Ed Yardeni Sees Upside of 10% for U.S. Stocks
The veteran market watcher thinks President Trump will deliver on market-friendly policies
Shortly after the Dow Jones Industrials broke above 20,000 two weeks ago, the market took a fright. Blame it on the turmoil of President Donald Trump’s first week or so in office, in which he signed an order to begin building a wall between the U.S. and Mexico, cleared the way for the Keystone XL pipeline, and put a temporary ban on admission to the U.S. of refugees and travelers from seven Muslim-majority countries.
Yet Trump’s plan to reduce government regulation, if implemented, could have a salutary effect on stocks, says Ed Yardeni, president and chief investment strategist of Long Island–based Yardeni Research. Yardeni expects stocks to keep rising, and thinks the market averages could add another 10% or so before a revival of “animal spirits” would provoke renewed caution.
Yardeni started his career on Wall Street in 1978 as chief economist at E.F. Hutton, and worked as an economist and investment strategist at several firms before founding Yardeni Research in 2007. In a recent interview, he shared his market views and some thoughts on current movies; readers of his daily newsletter are fond of his weekly film reviews. He also divulged that he is writing a book, Predicting the Markets: A Professional Autobiography, which he hopes to self-publish this summer.
Barron’s: Stocks have shot up since the election. Is this a blowoff, Ed?
Yardeni: It would be a mistake to bet against what President Trump might accomplish on the policy side. I’m giving him the benefit of the doubt, hoping good policies get implemented and bad ones forgotten. We could get substantial tax cuts. All his proposals don’t need to be implemented for the Trump rally to be validated. If you get $1 trillion to $2 trillion coming back from overseas because of a lower tax on repatriated corporate earnings, that would be very powerful in terms of keeping the market up.
In the nearly eight years since this bull market began in March 2009, companies have spent more than $5 trillion on stock buybacks and dividends. Having $1 trillion to $2 trillion come in over several months could lead to a 10% move to the upside, assuming there aren’t any restrictions placed on the money. A lot of companies will buy back shares; some will pay out more dividends. But what the heck: If they all put it into manufacturing plants and paid workers more, that would also be a positive.
You’ve been a busy bee, revising forecasts upward.
Nov. 8 [Election Day] was an extraordinarily important day, a major inflection point. It was a radical regime change. Suddenly I’m spending a lot more time writing about fiscal policy than monetary policy. This business is never dull. Before the election, I didn’t think it mattered to the market who won. The market would continue to move higher. To me it is all about P/E [stocks’ price/earnings ratio] times E [earnings estimate]. In August, Joe Abbott, our quantitative strategist, and I concluded the earnings recession was over. The picture had been dark because of the collapse in earnings and a plunge in oil prices. Now we’d have 8% to 9% earnings growth just because comparisons would be easy. In addition to energy, we saw strength in technology, industrials, and consumer discretionary.
When Trump won, he also had a majority in both houses of Congress. Suddenly we had to reread his economic policy proposals. We did some back-of-the-envelope calculations on reducing the corporate tax rate, recognizing it might go from an effective rate of about 27% after deductions to 15%. We concluded that earnings growth could be closer to 20% than 10%. We’re assuming the interest deduction disappears. We built in some cushion, in case we were too optimistic. But it still resulted in a huge increase in our Standard & Poor’s 500 earnings forecast, to $142 a share this year from $128. Frankly, I’m simply being conservative. A P/E of 17.6 gets us to 2500 by year end. If the market gets to 2500 sooner, I’ll reassess.
We are also betting tax cuts aren’t just for corporations but individuals. So economic growth will be more like 3% instead of the 2.5% we expected this year. As a result, we raised our outlook for the S&P 500 from 2300 to 2500.
Where could you both be wrong?
I hope Trump’s protectionism is really more about moving from free trade to fair trade and bilateral agreements, rather than shutting off trade relations. But renegotiating everything on a bilateral basis can get dicey. If Trump’s America-first approach is protectionist and triggers protectionist reactions, we’re all in trouble. Certainly we’d have to worry about a global recession. But I don’t expect him to kill off globalization. Too much money is at stake.
Could anything cause a panic in the markets?
A trade spat with China might. The Chinese would suffer a lot more. The U.S. went from an administration of—how shall I put it?—community organizers to one run by wheeler-dealers. The Trump team isn’t made up of professional politicians. But it isn’t out to destroy world trade; it is pro-growth. For example, Treasury Secretary nominee Steven Mnuchin believes sustained 3%-to-4% GDP growth is critical for the country.
The new administration is going to want to make deals. It is looking for weak points on the other side of the table and will press them. Trump changes his mind so much that it is pretty easy for him to say, “well, we got a better deal than I promised you,” and market it that way.
You said recently that the Age of the Central Banks is over. But the Fed remains important. What will it do this year?
Over the past eight years it was Ben, Ben, Ben, or Janet, Janet, Janet [former Federal Reserve Chairman Ben Bernanke, and current Chair Janet Yellen]. At least 50% of my daily briefing was some commentary about central banks. Now it’s fiscal policy. The central banks have done all they can [to spur economic growth]. For the past year, they have called for more assistance from the fiscal side. Beware of what you wish for.
What do you mean?
A few months ago key Fed officials were saying “we need fiscal policy to come in so we can normalize monetary policy.” Now they are saying they might have to raise interest rates more aggressively. They’re already starting to say we don’t need fiscal stimulus, which is ironic. The Fed could lift rates two or three times this year, by 25 basis points [a quarter of a percentage point] each. Four rate hikes are possible. Fed officials, no matter what they think of this president, must be relieved by the attention on fiscal stimulus, which gives them plenty of cover to get some room between the federal-funds rate and zero. The next time there is a recession, they will have some room to ease.
The real risk is a resumption of the “Old Normal,” wherein booms followed busts, as opposed to the New Normal since the financial crisis. The next bear market will come, as it always has, when we have the next recession. In the old-normal business cycle, we’re at full employment and don’t need more fiscal stimulus. But if there is an economic boom, there aren’t enough workers to achieve a lot of Trump’s stated goals. Workers long for the pay they got in the good old days, but many are already employed. If wages take off and are seen as price inflation, the Fed will have no choice but to tighten more aggressively. I’m back to being an old-fashioned business-cycle economist who thinks we need to watch wage pressures.
How big a risk is the strength of the dollar? After all, more euro turmoil seems inevitable with elections scheduled in France, Germany, and the Netherlands.
We’ve examined earnings for signs of the strong dollar being a drag. The profit cycle drives the business cycle. Profitable companies hire people and unprofitable ones slash payrolls and capital spending. Anecdotally, some companies say the strong dollar has an adverse impact. But it has had benefits for importers and retailers. I’m hard-pressed to say it had that much of a negative impact. Even though the dollar is up 25% since July 2014, it hasn’t hurt earnings by much.
The markets again are focused on putting a valuation on earnings. The Mexican stock market has held up remarkably well as the peso has dropped. In the U.K., despite Brexit [Britain’s vote to leave the European Union], economic indicators have been relatively strong, and there are moves for bilateral trade between the U.S. and the U.K. The European economies look like they’re improving. The weak currency is helping.
What film does this market remind you of?
Rocky, which is about a fighter who gets knocked down but never knocked out, and is still fighting in the ring.
Which sectors will win and lose?
Since 2010, we have talked about staying home instead of investing globally. This call hasn’t been brilliant all the time. I recommended jumping into Japan when the Japanese stock market had its big move in late 2013, but you also had to short the yen. On balance, “stay at home” strategy has outperformed “go global.” Now we have a president who says America first, so I’m even more comfortable staying at home. Financials had a big move but are still relatively cheap. Our contributing editor Jackie Doherty and I looked at the latest quarterly numbers and concluded the strength came from more volatility in the fixed-income markets giving banks more trading profits. The benefits in the yield curve, as [JPMorgan Chase CEO] Jamie Dimon says, are still ahead. There could be a lot more merger and acquisition activity, and initial public offerings ahead.
In a stay-at-home environment, you want small- and mid-cap companies, as opposed to large-cap. Some smaller-cap financials have had big moves, but on a relative valuation basis financials still look good. If the administration does manage to undo the Dodd-Frank financial-overhaul law from 2010, it’s consistent with my bullish stance on financials: Deregulation will lower their regulatory, compliance, and legal costs.
In technology, we like semiconductors. They have had a big move and aren’t cheap, but there is likely to be more M&A activity and earnings could continue to improve. We’re talking about major secular disruptions in autos, consumer electronics, and gaming.
We also like home builders. This isn’t a new bull market. You have to look where the value is. We have yet to see any convincing signs that millennials are coming into the market to buy homes. They have to: As they get to their 30s, they’ll get married, have kids, move to the suburbs. There is a shortage of existing homes. Look how quickly the builders catered to millennials who wanted to rent. Demand for single-family homes, attractively priced, will be there.
What is your view on health-care stocks, which had a tough two years?
Every time the president says anything about controlling drug prices, biotech suffers with the major drug companies. But the major drug companies will need to buy biotechs just to keep their pipelines full. Finally, it is really hard to like bonds here. I could see the yield on the 10-year bond getting to 3% by the end of the year. That isn’t great for utilities, telecommunication services, or consumer staples.
What movie will win the Oscar for Best Picture this year?
Probably La La Land, which is a Hollywood favorite. My personal choice is Lion.